Teranga Gold signs new agreement in Senegal

Teranga Gold (TGZ-T, TGZ-A), which has been producing gold from its Sabodala open-pit gold mine in the Republic of Senegal since March 2009, has agreed to amend its stability agreement with the government to increase the royalty rate on production to 5% from 3% to bring it in line with prevailing rates in the rest of West Africa.

The Toronto-based junior has also agreed to start paying a portion of accrued dividends on the state’s 10% interest in Sabodala earlier than planned to help the cash-strapped government meet its needs. Under the original agreement, Teranga had committed to paying the dividend only after it had recouped its capital from the mine.

In exchange, the government has waived its right to take an additional 25% stake in any deposits that Teranga may develop and put through the Sabodala mill from its regional exploration permits or any ground it may acquire in the future, for that matter, that are not part of the company’s 33-sq-km mining licence it currently holds on Sabodala. (Teranga’s mining licence on the 33 sq km land package in southeastern Senegal’s Birimian geological belt includes the Sabodala pit and the Masato, Niakafiri, Niakafiri West, Soukhoto and Dinkokhono deposits.)

Outside Teranga’s mining licence, the company also owns interests in ten exploration permits encompassing about 1200 sq km, which the company refers to collectively as its regional land package. Last year it spent $20 million on exploration there and over the past twenty-four months has identified at least 40 anomalies, targets and prospects. Teranga holds stakes in the ten exploration permits ranging from 70% (through joint ventures) to 100%.

Under the new agreement, Teranga will be allowed to process material from any deposits found on its regional land package—such as its Gora deposit—in exchange for an upfront royalty payment of 1% based on the size of the deposit and the gold price and only after Teranga receives all the permits it requires to mine the deposits.

“We won’t make any payments until we get all the permits,”explains Kathy Sipos, Teranga’s head of investor relations. “They need money and we need production.”

Effectively it works out to a 1% royalty on the additional ounces that Teranga will put through the mill. Teranga pays the royalty upfront based on the size of the deposit, capped at $10 million. The company then starts paying 1% in the year that the amount owed for the deposit exceeds the initial $10 million.

At Gora, for example, Teranga’s most advanced satellite deposit, about 26 km from the Sabodala mill, money owed to the government will be based on the reserves used in the feasibility study (285,000 ounces at a 95% recovery rate, or 270,750 oz.) After the government’s 5% royalty is factored in, the number of gold ounces drops to 257,213. That number is then multiplied by $16.50 per oz. (1% of the average realized gold price over the last twelve months, or US$1,650 per oz.) for a payment to the government once all the permits it needs to put Gora into production have been received.

“This provides the government with a significant upfront payment which should incentivize them to move the deposit through the permitting process efficiently and is fair for both parties,” Sipos explains in a subsequent email, “as the amount is a function of both the gold price ($/oz we pay goes up or down depending on the gold price) and the size of the deposit (we pay based on the number of ounces we produce through the mill).”

To make the math simpler, if a deposit has 1 million recovered ounces after the government royalty is paid, Teranga would owe 1 million oz. times $16.50 per oz., or $16.5 million. The company would pay $10 million upfront on receipt of all permits and then after producing about 606,000 ounces (10 million oz. multiplied by $16.50) the company would start paying 1% of annual production each year.

Under the new agreement announced Apr. 2, the government has also agreed to support Teranga’s drilling on the Niakafiri deposit (which is on the existing mine licence). And it has agreed to extend the term of the mining licence by five years to 2022. The Senegalese have also agreed to extend five key exploration licences by a further 18 months beyond their current expiry dates and promised to ensure full access to exploration targets currently occupied by artisanal miners.

Sipos notes that Senegal president Macky Sall, who was elected in March 2012, is a geological engineer and understands that the country has fallen behind its neighbours in West Africa, particularly Mali to the south, when it comes to resource extraction. “He understands the industry, he understands mining, we’re the only operator in the country, and he needs the capital,” Sipos says.

According to BMO mining analyst Andrew Breichmanas, the agreement in principle offers both stability and opportunity. “The higher royalty brings the fiscal regime in Senegal more in line with its West African neighbors, but reduces NPV by roughly 10%,” the London-based analyst writes in a research note. “Longer term, the mechanism for acquiring participation rights suggests a strong level of government support, which could allow Teranga to leverage existing infrastructure at Sabodala and process ore from nearby satellite deposits.”

As of Dec. 31, 2012, reserves on the company’s mining licence totaled 33.13 million tonnes grading 1.22 grams gold per tonne for 1.3 million contained oz. gold.

In terms of exploration this year, Teranga has lowered its exploration budget due to market conditions and minimized development expenditures at Goro. Nevertheless, Goro remains on track to start production in 2014. The satellite deposit has measured and indicated resources of 374,000 oz. gold grading 5 grams gold per tonne.

The Gora pit is expected to produce about 500,000 tonnes of ore per year for four years with a grade ranging from 2.8 grams gold per tonne to 4.9 grams gold per tonne. The project capital cost is thought to be between $45 million and $50 million.

Total cash costs for Gora are estimated to average $675 to $700 per ounce sold on a life-of-mine basis. At a discount rate of 5%, the Gora deposit is expected to return an after-tax net present value of $105 million and an internal rate of return of 69%.

Richard Young, Teranga’s president and chief executive, noted in a press release announcing the new agreement in principal that even with the additional $10 million in costs associated with the agreement, management still expects to generate free cash flow and remains on track to eliminate its hedge book by the middle of 2013.

Teranga forecasts Sabodala will produce between 190,000 oz. gold and 210,000 oz. gold this year at total cash costs of US$650-700 per oz.